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The economics of flood insurance
The economics of flood insurance

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5.3 Weighing up the options

Even focusing just on the insurance aspect of flood risk, there were competing policies the government could adopt. The government compared them using a technique called Cost-Benefit Analysis (CBA).

Logo for Flood Re
Figure 14 Flood Re was the government’s preferred option

CBA is a way of weighing up the costs and benefits of different possible options in order to inform the decision about what to do. Any positive impacts are evaluated as benefits and any negative impacts are evaluated as costs. A process of discounting is used, which gives greater weight to costs and benefits occurring today or in the near future than those that will take longer to materialise.

CBA aims to express all costs and benefits in monetary terms so that options can be compared against each other and also against the benchmark of ‘do nothing’ (also called the ‘counterfactual’ or ‘business as usual’). The ‘do nothing’ option is not the same as ‘no change’, because in the baseline situation there may be forces for change at work. In the flood insurance case, without government intervention the flood insurance market would have changed radically with a shift to fully risk-based pricing.

The government chose to include in its flood-risk CBA a shortlist of four options in addition to the baseline. However, it made clear that its preferred option was a scheme called ‘Flood Re’. This involved ensuring that a cross-subsidy from lower-risk to higher-risk insurance customers would continue. In essence, all insured customers would pay a little bit more for their home insurance and the money raised would be used to put a cap on the maximum amount that households would have to pay for the flood insurance part of their cover.